The tides have changed in light of inflation
For the last 15 years, multifamily and commercial real estate investors surfed an ever-cresting wave of bolstered property valuations aided by abundant and cheap capital. Those ideal surfing conditions have now practically ebbed, however, a CRE veteran told Mortgage Professional America.
Currents gained the upper hand and liquidity washed away in 2022, Joseph Rubin (pictured), senior advisor at EisnerAmper’s real estate practice, told MPA in a recent telephone interview. He spoke to MPA on the heels of having written his most recent article titled Multifamily and Commercial Real Estate Investing in 2023.
By now, the culprit of this downshift is widely known: The return to higher interest rates powered by the Fed’s wrestling match with inflation, he said. But for a while, the sectors had been shielded from the most corrosive effects of higher interest rates.
Is owning multifamily worth it?
Not anymore. This is what Rubin has heard “‘My clients only do multifamily, so they’re fine’. Well, no. That’s not the case. That’s not the case at all. There are definitely some risks in multifamily as well, and I’m not sure the investors – especially the retail investors, in limited partners in these deals who bought probably for income – recognize the current environment if they’re not real estate professionals. They don’t know what’s going on.”
To be sure, such investments are just as vulnerable in today’s volatile market, he said. What makes them more vulnerable? “Two things,” Rubin said. “One, the fundamentals, meaning supply and demand, are not quite as they were before and the more important reason – the debt market changes. If you think about the fundamentals side, we had tremendous rent growth in multifamily during the pandemic and the properties were cash-flowing and some people felt that was going to continue indefinitely, which was, of course, impossible because there was too much rent growth. And so what you had was some of these markets where people were moving to because they were more affordable - over the last three years, rents are up 50%, and they’re no longer affordable.”
Such as it is with nature finding a way, so does the invisible hand of the market: “All the statistics are showing rent growth is coming down to historically normal levels – 2% to 3% a year maybe, not 10%, 13%, 20%, 25% in some markets. And in some markets that had significant growth, we’re really seeing rents decline now. Of course, the other piece of the puzzle is that, for many years, there wasn’t a lot of construction of new units in multifamily. But over the last few years, it’s really ramped up. There’s always an imbalance, right? Before you had too few, now you have too many.”
Rubin knows of what he speaks, with more than 35 years of experience across the real estate industry offering a wide expertise on the breadth of the industry – from family-owned business, REITs, PE funds and financial institutions, to improving governance, transparency reporting and succession planning for high net worth individuals.
Investment advice
Given all that he’s seen in his storied career, Rubin doesn’t mince words in his most recent paper, in which he further advises would-be investors: “If it comes as any consolation, the current threat to property values and yields was not the industry’s doing but rather the result of shifts in the economy and the capital markets,” he wrote. ”Supply and demand are relatively in balance and most property sectors have been generating generous returns for their investors. But as rental growth slows from the almost absurd rates seen in the last few years, and inflation pushes up wages and other operating costs, property cash flows are likely to be squeezed. In combination with a higher cost of capital, that means falling asset values. Some reports are saying we are not in a downturn but a return to normal conditions. That’s wrong and right. We are returning to historically normal conditions in terms of higher rates and improved wage inflation, but this new reality will cause values to fall and, having been through quite a few, I call that a downturn in the cycle.”
He breaks down the market shift: “The transition from a policy-induced boom market to a market-based real estate investment environment will be rough for a lot of owners. Even if the Fed backs down later this year, or in 2024, higher interest rates are here to stay. The biggest deterrent to capital flows is uncertainty, and not knowing where rates will land will keep liquidity on the sidelines and prolong the process of price discovery. The search for clarity won’t be solved in a few months, it will take time for sellers to capitulate to new pricing and for lenders to believe in the new valuations. We may not understand the full extent of sector distress until we move through hundreds of billions of dollars of loan maturities in the next several years. But real estate companies and banks are healthy, property fundamentals remain relatively strong, and, like so many times before, the industry will adjust to the new market conditions and capital will flow once more.”
Indeed, the tides have changed.
